Who bears the burden of federal excise taxes?
Workers, owners of capital, and households that consume a disproportionate amount of taxed items all bear the burden of federal excise taxes.
Excise taxes create a wedge between the price paid by the final consumer and what is received by the seller. An excise can either raise the total price (inclusive of the excise tax) paid by consumers or reduce the amount of business revenue available to compensate workers and investors.
The burden of an excise can be separated into two pieces: (1) the reduction in real household income, which in total is equal to the gross revenue generated by the excise tax, and (2) the increase in the price of the taxed good or service relative to the prices of other goods and services, which depends on the relative mix of consumption by each household and is equal to zero across all households. Note that the decline in real income is the same regardless of whether nominal incomes fall (holding the price level constant) or whether the price level rises (holding nominal incomes constant).
Reduction in Real Income
The reduction in real income is spread across wages, profits, and other returns to labor and capital. The reduction in wages in turn reduces both individual income taxes and payroll taxes. Likewise, the reduction in profits reduces corporate income taxes and individual income taxes on the profits of pass-through business (like partnerships) and other returns to capital. These “excise tax offsets” amount to about 25 percent of excise tax revenues and are taken into account in distributional analyses.
Change in Relative Prices
An excise tax also increases the price of the taxed good or service relative to the prices of all other goods and services. While the price of the taxed item rises, the prices of all other items may either remain unchanged, as the overall price level rises, or may fall slightly if the price level remains unchanged. Either way, this change in relative prices burdens households that consume a larger than average share of the taxed item. However, households that consume a smaller than average share of the taxed item, or do not consume it at all, benefit from this change in relative prices.
Timing of the Tax Burden
This still leaves open the issue of the timing of the tax burden—that is, whether the burden is assigned when income is earned or when it is consumed. Some distributional analyses follow the latter approach and distribute excise taxes in proportion to current levels of consumption. Alternative analyses assign the burden based on current income. Under the income-based approach, one can think of excise taxes as a reduction in purchasing power at the point income is earned. Of course, if all households fully consumed their income in each year, the two methods would yield identical results.
The Urban-Brookings Tax Policy Center distributes the burden of an excise tax when income is earned, taking into account the “offset” and the relative price effect. The US Department of the Treasury’s Office of Tax Analysis, as described in Cronin (1999), distributes excise taxes in the same manner. The Joint Committee on Taxation and the Congressional Budget Office, however, distribute the entire burden of excises in proportion to consumption of the taxed goods and services.
Distribution of Federal Excise Taxes
While the share of federal excise tax paid rises with incomes, federal excises are regressive as the average federal excise tax rate (the excise tax burden as a percentage of pre-tax income) declines as income rises. The average tax rate falls from 1.5 percent in the bottom quintile, to 0.5 in highest quintile, and to 0.3 percent of income in the top 1 percent. (Each quintile contains 20 percent of the population, ranked by income.) Federal excise taxes are over 40 percent of the total federal tax burden (including individual and corporate income taxes, payroll taxes, the estate tax, and excise taxes) in the bottom quintile and over 12 percent in the second income quintile (table 1).
Federal excise tax revenues totaled $98.3 billion in fiscal year 2015, or 3.0 percent of federal tax revenues. Five categories of excise taxes—highway, tobacco, air travel, health, and alcohol—accounted for about 90 percent of total excise tax receipts in that year.
The distributional burden varies somewhat across the different categories of excise taxes (table 2). The most noticeable is the tobacco excise tax, for which the share of tax paid is nearly constant across income quintiles. The bottom quintile pays 18.4 percent of tobacco taxes and 23.7 percent of penalties under the Affordable Care Act (ACA) (compared to 4 to 5 percent of other excises), while the top quintile pays just 26.3 percent of tobacco taxes and 18.8 percent of ACA penalties (compared to about 45 to 50 percent of other excises). Tobacco taxes and ACA penalties are the most regressive of the major federal excise taxes. The remaining categories vary only modestly. Excise taxes on air travel are tilted the most toward higher income households, with 52.4 percent of these excises paid by households in the top income quintile.
Urban-Brookings Tax Policy Center. Table T16-0094. “Effective Federal Tax Rates—All Tax Units, by Expanded Cash Income Percentile, 2017.”
———. Table T16-0104. “Share of Federal Taxes—All Tax Units, by Expanded Cash Income Level, 2017.”
Congressional Budget Office. 2016. “The Distribution of Household Income and Federal Taxes, 2013.” Washington, DC: Congressional Budget Office.
Cronin, Julie-Anne. 1999. “U.S. Treasury Distributional Analysis Methodology.” OTA paper 85. Washington, DC: US Department of the Treasury.
Joint Committee on Taxation. 1993. “Methodology and Issues in Measuring Changes in the Distribution of Tax Burdens.” JCS-7-93. Washington, DC: Joint Committee on Taxation.